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Assignment
7
Ahmed Abdelhamed
University of the Cumberlands
Corp Fin: Fiscal Mngmnt GloCul (BADM-734-M40) - Full Term
Dr. Adu Bonna
October 14
th
, 2023
Capital Budgeting Theory and Practice
Abstract
This research paper aimed to delineate lacunae in the extant capital budgeting theory and
practice by collecting research papers published. During the last twenty years in multiple
databases. This research focused on capital budgeting, capital budgeting decision, capital
budgeting theory, capital budgeting practices, capital budgeting methods, capital budgeting
models, capital budgeting tools, capital budgeting techniques, capital budgeting process and
investment decision. It identified factors impinging on choice of capital budgeting practice.
Many researchers have studied capital budgeting during the last five decades, but due to
globalization, environmental changes and cutting edge advanced technological developments,
many of the theories and models developed in the past do not applicable today.(Kengatharan,
2016)
Problem Statement
Web of science search and iCat search were used to locate research papers published
during the last twenty years. The research papers were collected from Kingston University
library's access service. Firms operating in a dynamic environment must respond to changes by
investing large sums of money over a long period. Capital budgeting investment decisions are
critical to survival and long-term success for firms due to many factors, including uncertainty.
One of the most intractable issues confronted by researchers is how to identify, capture, and
evaluate uncertainties associated with long term projects. There are number of methods assist in
making capital budgeting decisions, but other uncertainty factors have deleterious penetration.
Nowadays, complex methods are used for making capital budgeting decisions rather purely
depending on theories of capital budgeting because of uncertainty and other contingency factors.
In a world of geo-political, social as well as economic uncertainty, strategic financial
management is a process of change. This research assumes that capital budgeting practices are
different across firms/ nations and that the ways of looking at capital budgeting practices are not
the same all the time. Therefore, the ontological assumption is of constructionism.
Significance & Purpose of the study
During the past twenty years, 202 research papers appeared in peer reviewed indexed
journals in capital budgeting. The majority of the papers appeared in Engineering Economist (N=
32), followed by Managerial Finance (27), Public Budgeting & Finance (16), Financial
Management(9), Journal of Banking and Finance (8), Journal of Business Finance & Accounting
(6), Accounting Education(5), Management Accounting Research(5), The Journal of
Finance(5).Capital budgeting is the process of deciding investment projects which create in
maximization of shareholder value. It is generally prepared a year in advance and extendable to
five, ten or even fifteen years in future. The most prevalent capital budgeting techniques in the
public finance literature include payback period, accounting rate of return, net present value,
internal rate of return, benefit -cost ratio, and profitability index. The PB model is criticized for
failing to make accurate assessments of project value, as it does not consider use of cash flows,
time value of money, risk in a systematic manner, and further it does not identify investment
projects that will maximize profits. The NPV model measures the difference between present
value of the money in and present value of the money out and determines whether or not a
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capital investment is acceptable. The discounted cash flow (DCF) analysis method is used to
assess capital budgeting, and the net present value (NPV) and internal rate of return (IRR)
methods are considered to be non-DCF methods. The PI model is used to overcome the time
value of money and the size of the investment. Graham and Harvey (2001) reported that twelve
capital budgeting methods were in practice, but all of them were not in usable at all situations.
Discounted payback and Value-at-risk were relatively new methods, and APV additionally
covered the value of financial side-effects of an investment to NPV. Real option theory is closely
related to corporate capital investment decision -making and has been introduced as an
alternative approach for investment appraisal under uncertainty. It involves the use of investment
evaluation tools and processes that properly account for both uncertainty and the company's
ability to react to new information. Many researchers have argued that real options analysis has
an advantage over NPV, since NPV is not able to capture the value of managerial flexibility.
Although this method has not been applied on a large scale in practice, it is mostly applicable in
specific industries or situations.
Research Method
Web of science search and iCat search were used to locate research papers published
during the last twenty years. The research papers were collected from Kingston University
library's access service. Methodology covers research philosophy, research approach, research
strategy, methods of data collection and data analysis.
Critical analysis
Many research scholars criticized that many researches on capital budgeting were opt-
testing the methods of capital budgeting and its practices. This research was well thought out in
its design and become springboard for future research.
References
Kengatharan, L. (2016). Capital Budgeting Theory and Practice: A Review and Agenda for Future
Research.
Applied Economics and Finance
,
3
(2), 15–38.
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